Top Ten: Procedural Options to Resolve Conflicts of Interest

INTRODUCTION

When an insurer reserves its rights to later deny coverage it always creates some conflicts of interest with its policyholder.[1] But “not every conflict of interest triggers an obligation on the part of the insurer to provide the insured with independent counsel at the insurer’s expense.”[2] The test for whether a reservation of rights creates a disqualifying conflict of interest[3] that requires the insurer to pay for independent counsel selected and directed by the policyholder[4] is whether the coverage issues reserved “have nothing to do with”[5] disputed issues in the liability dispute.[6] When the insurer and the policyholder disagree whether the insurer must pay for independent counsel it is important to obtain a judicial determination of the question. There are several procedural options available to do so.

Ten procedural options are available to resolve a dispute whether an insurer must pay for independent counsel are: 1) Acquiesce to the insurer; 2) Negotiate while developing evidence of conflicts; 3) Withhold consent and authorization for dependent counsel to represent the policyholder; 4) Resist dependent counsel’s motion to withdraw; 5) file a motion in the liability action to disqualify dependent counsel; 6) Sue the insurer for declaratory relief; 7) File a motion to stay a declaratory relief action; 8) File a motion for summary adjudication in a declaratory relief action; 9) Sue the insurer for damages; and 10) Sue dependent counsel for breach of fiduciary duty.

TWO FIELDS OF CONFLICTS

A reservation of rights always creates two fields of closely related[7] conflicts of interest for the policyholder: one with the insurer and another with dependent counsel.[8] Because insurer conflicts are rooted in dependent counsel’s ethical conflicts, resolution of one field of conflicts often produces resolution in the other field of conflicts.

PROCEDURAL OPTIONS

1.   Acquiesce to the Insurer

The most common choice policyholders make is to acquiesce to the insurer’s reservation of rights.[9] While acquiescence is good for cash flow, doing nothing fails to develop evidence of conflicts of interest[10] and permits the insurer to apply a disadvantageous hindsight test.[11]

2.   Negotiate While Developing Evidence of Conflicts

A very low cost option to resolve conflicts of interest is to negotiate with the insurer and with dependent counsel.[12] A good start is to nicely request that the insurer limit or withdraw its reservation of rights[13] coordinated with nicely asking dependent counsel to comply with the rules of ethics.[14] As a party who may seek to settle with the policyholder for an assignment of insurance rights,[15] the plaintiff may independently seek to develop evidence of conflicts of interest.[16] Many judges are very confused by conflicts of interest that arise when an insurer reserves its rights.[17] Good manners count in a coverage dispute.[18] “The better practice . . . would be to cooperate with appointed counsel until an actual conflict develops.”[19]

3.   Withhold Consent and Authorization from Dependent Counsel         

Another low cost option to resolve conflicts of interest is to simply withholder consent to be represented by dependent counsel. As the beneficiary of a fiduciary relationship with the insurer[20] and a separate fiduciary relationship with dependent counsel,[21] the policyholder/client wields significant power. The policyholder may withhold consent for dependent counsel to represent the policyholder,[22] withhold consent for dependent counsel to be paid by the insurer,[23] withhold authority for dependent counsel to appear in court,[24] and direct dependent counsel to refrain from communicating confidential coverage information to the insurer.[25] Taking these steps serially will likely test dependent counsel’s ethical compliance threshold. Withholding authority to appeal is court will likely result in a motion to withdraw as counsel.

4.   Respond to Dependent Counsel’s Motion to Withdraw

When dependent counsel has made an appearance as an attorney or record in a liability dispute, the lawyer may make a motion to withdraw for cause. There are two relevant reasons for an attorney to withdraw: 1) “continued employment will result in violation of these rules [Rule 3-310] or of the State Bar Act [Bus&Prof. Cd. §6104[26]]; and 2) a personality conflict with the client.[27] One of the reasons why all dealings between the policyholder and dependent counsel should be cordial is so that dependent counsel cannot justify withdrawal on the ground of a personality conflict. That leaves only one basis upon which dependent counsel may withdraw – that continued representation would result in violation of Rule 3-310 because of a disqualifying conflict of interest. The policyholder, not independent counsel, should file a pleading in response to a motion to withdraw requesting that the trial court decide either: 1) the reservation of rights does create a disqualifying conflict, in which case dependent counsel should be recused; or 2) the reservation of does not create a disqualifying conflict, in which case dependent counsel should be allowed to remain as counsel of record.[28] A trial court order that dependent counsel has a disqualifying conflict of interest may create a valuable foundation to establish that the insurer’s reservation of rights requires it pay independent counsel. An insurer that refuses to pay independent counsel following such a ruling may risk being in breach of its duty to defend.[29]

5.   File a Motion to Disqualify Dependent Counsel

A somewhat more expensive option is for the policyholder to file a motion in the plaintiff’s liability lawsuit to disqualify dependent counsel.[30] Such motions are usually filed by one party to disqualify an attorney on the opposing side. Motions to disqualify one’s own attorney are not common because a client can fire an attorney at will with or without cause,[31] so such a motion can be a bit awkward. If the trial court grants the motion and specifies grounds that dependent counsel has disqualifying conflicts of interest, this ruling should prompt the insurer to agree to pay independent counsel or risk being in breach of its duty to defend. If the motion is denied, the policyholder can appeal which may create an incentive for dependent counsel and the insurer to promptly settle the liability dispute.[32]

6.   Sue for Declaratory Relief

A somewhat risky and potentially expensive option to resolve conflict of interest issues is to file a second, separate lawsuit for declaratory relief.[33] Such actions are entitled to priority in trial setting.[34] The scope of a declaratory relief action should be limited to issues relating to the insurer’s duty to defend, not ultimate issues of coverage that may prejudice the policyholder’s defense.[35] However, some insurers may respond to service of such a suit by negotiating resolution of the conflicts issues. Filing a verified complaint may require the insurer to state under oath whether it irrevocably concedes that it has a duty to defend and that a disqualifying conflict of interest exists that may impact the applicability of Civil Code §2860, including its rate limitation.[36]

7.   File a Motion to Stay a Declaratory Relief Action

One very good reason to file an action for declaratory relief is to create the opportunity to quickly and easily get a trial court ruling that disqualifying conflicts of interest exist. However, litigating coverage while the liability suit is still pending may threaten to prejudice the policyholder’s defense. “To eliminate the risk of inconsistent factual determinations that could prejudice the insured, a stay of the declaratory relief action pending resolution of the third party suit is appropriate when the coverage question turns on facts to be litigated in the underlying action. [Only] when the coverage question is logically unrelated to the issues of consequence in the underlying case, the declaratory relief action may properly proceed to judgment.”[37] A trial court order granting a stay should specify that the insurer’s reservation of rights does create disqualifying conflicts of interest because the issues to be decided in the declaratory relief action are logically related to disputed issues being litigated in the liability suit.

8.   File a Motion for Summary Adjudication in a Declaratory Relief Action

The existence of an insurer’s duty to defend and the existence of disqualifying conflicts of interest are appropriately and easily resolved by motions for summary adjudication. Because the duty to defend turns on “potential” coverage, all that policyholder needs to show is that it is possible for the liability lawsuit to result in a judgment that is covered by the policy. “It is appropriate to recall at this point the procedural ramifications of rulings on motions for summary judgment in actions seeking a declaration of the existence or nonexistence of the duty to defend. When an insured successfully moves for summary judgment that the insurer owes a defense duty, the insurer’s duty is clear. If an insurer successfully moves for summary judgment that it owes no duty to defend, the absence of a duty is clear. But an unfavorable ruling on the insured’s motion does not establish the absence of a defense duty; it merely means that the question whether the insurer must defend is not susceptible of resolution by undisputed facts, but instead must go to trial. In the interim, presumably there continues to exist a potential for coverage and thus a duty to defend. [W]hen the evidence adduced in the declaratory relief action does not permit the court to eliminate the possibility that the insured’s conduct falls within the coverage of the policy, the duty to defend is then established, absent additional evidence bearing on the issue. If the insurer, having defeated the insured’s motion for summary judgment, seeks to escape the defense duty altogether, it must present proof of the kind described in the preceding paragraph, i.e., evidence that the underlying claim cannot come within the policy coverage by virtue of the scope of the insuring clause or the breadth of an exclusion. In order to avoid any possibility that a refusal to defend may subject it to eventual liability for bad faith, the insurer is well advised to seek a judicial determination that it owes no defense. This it may do by means of a cross-motion for summary judgment in the declaratory relief action.[38]

Similarly, the legal issue of an insurer’s duty to pay for independent counsel is susceptible to summary adjudication because of the substantive law of the Cumis Rule.[39] Dependent counsel must comply with Rule 3-310[40] because the lawyer always represents the interests of the insurer[41] and jointly represents the policyholder as a party to the liability suit. If dependent counsel fails to comply with Rule 3-310, then the insurer must pay for independent counsel because the insurer’s obligation is derivative of the lawyer ethical conflicts.[42] Dependent counsel must be disqualified[43] unless the issues raised by the insurer’s reservation of rights[44] “have nothing to do with”[45] the issues in the liability lawsuit. If dependent counsel is disqualified, the insurer must pay for independent counsel. (See, fn. 4.)

9.   Sue the Insurer for Damages

Many policyholders feel a need to sue the insurer for damages flowing from various breaches, including the duty to defend[46] and the duty to settle.[47] An action for damage is not entitled to priority in trial setting (although declaratory relief is) but it is often prudent to get a complaint on file early, even if it is stayed, so that time ticks away while the plaintiff’s liability suit is pending. At a later time, the coverage suit may be entitled priority in trial setting simply because it is old.

10. Sue Dependent Counsel for Breach of Fiduciary Duty

Developing evidence[48] of dependent counsel’s ethical conflicts of interest is important preparation for another procedural option to resolve conflict of interest issues. The policyholder can sue dependent counsel for breach of fiduciary duty grounded upon the lawyer’s failure to comply with Rule 3-310. Such a suit may take the form of declaratory relief, a suit for damages, or both. If it becomes important to remove dependent counsel from the liability suit, a separate suit against dependent counsel is virtually guaranteed to persuade dependent counsel to withdraw.[49]

 


[1] See, Cumis Rule.

[2] James 3 Corp. v. Truck Ins. Exchange (2001) 91 Cal.App.4th 1093, 1101.

[4] [L]awyers hired by the insurer [must] explain the full implications of joint representation in situations where the insurer has reserved its rights to deny coverage. If the insured does not give an informed consent to continued representation, counsel must cease to represent both. Moreover, in the absence of such consent, the insurer must pay the reasonable cost for hiring independent counsel by the insured.” (San Diego Navy Fed. Credit Union v. Cumis Ins. Society, Inc. (1984) 162 Cal.App.3d 358, 375 (Cumis) (citations and ellipses omitted).)

[5] “[W]hen the reservation of rights is based on coverage disputes that have nothing to do with the issues being litigated in the underlying action . . . there is no conflict of interest.” (Long v. Century Indemnity Co. (2008) 163 Cal.App.4th 1460, 1470 (Long).)

[6] See, Cumis Test – MoL

[11] See, Difference Between the Cumis and Dynamic Concepts Lines of Cases – MoL

[12] See, Insurer Reserves Rights But Refuses to Pay Independent Counsel – AG

[13] See, Policyholder Develops Admissible Evidence of Insurer Conduct – AG

[14] See, Policyholder Challenges Ethics of Conflicted Dependent Counsel – AG

[16] See, Plaintiff Develops Admissible Evidence of Dependent Counsel’s Ethical Breaches and Plaintiff Develops Admissible Evidence of Insurer Conduct.

[17] “[T]he professional obligations of counsel who represents a liability insurer as well as its insured — needs clarification.” (Industrial Indem. Co. v. Great American Ins. Co. (1977) 73 Cal.App.3d 529, 531.)

[18] See, Don’t Be Rude – PP

[19] Midiman v. Farmers Ins. Exchange (1999) 76 Cal.App.4th 102, 123.

[20]Insurers hold themselves out as fiduciaries, and with the public’s trust must go private responsibility consonant with that trust.” (Egan v. Mutual of Omaha Ins. Co. (1979) 24 Cal.3d 809, 820-21.)

[21] “[T]he dealings between practitioner and client frame a fiduciary relationship.” (Neel v. Magana, Olney, Levy, Cathcart & Gelfand (1971) 6 Cal.3d 176, 188-89.)

[22] “A [lawyer] shall not, without the informed written consent of each client: (1) Accept representation of more than one client in a matter in which the interests of the clients potentially conflict.” (Rule 3-310(C).)

[23] “A [lawyer] shall not accept compensation for representing a [policyholder] from [an insurer] unless . . . The [lawyer] obtains the client’s informed written consent.” (Rule 3-310(F).)

[24] “Corruptly or wilfully and without authority appearing as attorney for a party to an action or proceeding constitutes a cause for disbarment or suspension.” (Bus.&Prof. Cd. §6104.)

[25] “[C]onfidentiality is essential where communication can affect coverage. Thus, the lawyer is forced to walk an ethical tightrope, and not communicate relevant information which is beneficial to one or the other of his clients.” (Cumis, supra, 162 Cal.App.3d at 366.)

[26] “Corruptly or wilfully and without authority appearing as attorney for a party to an action or proceeding constitutes a cause for disbarment or suspension.”

[27] See, Estate of Falco v. Decker (1987) 188 Cal.App.3d 1004, 1014.

[28] See, Policyholder Response to Dependent Counsel’s Motion to Withdraw.

[30] See, Motion to Disqualify – MP

[32] See, Motion to Disqualify – CS

[33] “Any person who desires a declaration of his or her rights or duties with respect to another may bring an original action for a declaration of his or her rights and duties. The declaration may be had before there has been any breach of the obligation in respect to which said declaration is sought.” (Cd. Civ. Proc. §1060 (ellipses omitted).)

[34] Cd. Civ. Proc. § 1062.3.

[35] See, Verified Complaint: for Declaratory Relief – MP

[37] Montrose Chemical Corp. v. Superior Court (1993) 6 Cal.4th 287, 301-02 (Montrose) (citations and ellipses omitted).

[38] Id. at 301 (citations, ellipses, and quotation marks omitted).

[39] See, Cumis RuleMoL

[44] See, Cumis TestMoL

[45] “[W]hen the reservation of rights is based on coverage disputes that have nothing to do with the issues being litigated in the underlying action . . . there is no conflict of interest.” (Long, supra, 163 Cal.App.4th at 1470.)

[46] See, Duty to DefendMoL

[47] See, Duty to SettleMoL

[49] See, Dependent Counsel Actively Attacks Coverage – CS

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